Euro Set for First Back-to-Back Annual Drop Since 2001 on European Crisis. The euro is set for its first back- to-back annual drop versus the dollar since 2001 on concern Europe’s debt crisis will weigh on the region’s economic growth. The 17-nation euro traded 0.3 percent from a decade low against the yen before data next week forecast to confirm European manufacturing contracted for a fifth month.

Credit Agricole Squeezed With BNP by Slide in French Corporate Bond Sales. Credit Agricole SA (ACA) and BNP Paribas SA, the top arrangers of French corporate debt sales this year, are girding for a slowdown in 2012 after companies raised the least amount in the second half since 2007. Bond sales by French companies have fallen 22 percent since July 1 compared with the year-earlier period to 62.6 billion euros ($81 billion), according to data compiled by Bloomberg. The market may shrink more as Standard & Poor’s considers whether to strip France of its AAA credit rating and Europe’s second-biggest economy enters a recession.

China's Manufacturing Contracts for Second Month, PMI Shows. China’s manufacturing contracted for a second month in December as global growth faltered and Premier Wen Jiabao prolonged a crackdown on speculation in the housing market. The index was 48.7 in December, HSBC Holdings Plc and Markit Economics said today. That compared with a preliminary result of 49 reported on Dec. 15 and a final reading of 47.7 for November. “Weakening external demand is starting to bite,” said Qu Hongbin, a Hong Kong-based economist for HSBC. Developer China Vanke Co.’s contract sales dropped 36 percent last month from a year earlier, while new home prices in Shanghai, Beijing, Shenzhen and Guangzhou slid from the previous month. In a sign that construction projects are slowing, Hitachi Construction Machinery Co., Japan’s second-largest heavy- equipment maker, said this month that Chinese demand for excavators will decline in the first half of next year.

Australia Home Prices Drop 3.7%. Home prices in Australia’s eight capital cities slid 3.7 percent in the first 11 months of 2011, extending the biggest drop in at least 12 years on concerns Europe’s debt crisis may damp the nation’s economic growth. Brisbane led the decline, slumping 7 percent in the January-November period, followed by Melbourne, which posted a 5.7 percent retreat, according to figures from RP Data, a real estate researcher. “The downside risk would come from global weakness affecting the Australian economy,” said David Cannington, a Melbourne-based economist at Australia & New Zealand Banking Group Ltd. (ANZ), with A$161 billion ($164 billion) of mortgages as of November. “The housing market will, broadly speaking, reflect the relative strength or weakness of the Australian economy.” Economists at the nation’s four-biggest banks, which hold 87 percent of mortgages, said the central bank’s interest rate cuts won’t be enough to offset concerns about Europe’s crisis or spur a rebound in the housing market. Home loans rose 5.7 percent in the 12 months through November, matching the weakest annual pace since 1977, central bank data showed today.

Fed Says Dealers Tighten Terms on Hedge-Fund Security Trades. Wall Street dealers made it tougher for hedge funds to finance trading of securities and derivatives in the three months through November, a Federal Reserve survey showed today. Responses “indicated a broad but moderate tightening of credit terms applicable to important classes of counterparties,” especially hedge-fund clients, trading real estate investment trusts and nonfinancial corporations, according to the quarterly survey of senior credit officers at 20 dealers covering the period of September to November.

North Korea Threatens South, Tells World To Expect No Change From Kim Jong Un.North Korea told “the world’s foolish politicians” to expect no change from the new regime headed by Kim Jong Un and threatened a “sea of fire” for South Korean President Lee Myung Bak’s administration. “The world will witness how millions of North Korean people, who transformed sadness to courage and tears to strength under the pillar of the great leader Kim Jong Un, will achieve final victory,” the commission said in the statement.

Slowing Chinese Growth Means Ore-Vessel Rates at Lowest in Decade: Freight. The weakest growth in demand in at least a decade for shipments of iron ore, the second-biggest commodity cargo after crude oil, means rates for the largest vessels will plunge to the lowest level since 2002. Capesizes, each hauling about 160,000 metric tons of ore, will earn an average of $15,000 a day next year, about 4 percent less than in 2011, the median estimate in a Bloomberg survey of 10 analysts shows. While that implies losses for ship owners and investors in their companies, speculators can profit because forward freight agreements, handled by brokers and used to bet on transport costs, are anticipating an average of $16,367, according to data from the London-based Baltic Exchange. Owners are contending with the biggest fleet in history as vessels ordered when rates reached $233,988 in 2008 continue to leave ship yards. The glut may widen because trade in iron ore will expand 2.5 percent next year as the number of capesizes rises 9.8 percent, according to Clarkson Plc, the world’s biggest shipbroker. Economic growth in China, whose steel mills consume 65 percent of all seaborne ore, will slow to the weakest since 2001, economist estimates compiled by Bloomberg show. “The question for ship owners now is how are you going to hang on, how long are you going to hang on, and when is the light at the end of the tunnel?” said Andreas Vergottis, the Hong Kong-based research director at Tufton Oceanic Ltd., whose $1.45 billion shipping hedge fund is the world’s largest. “There is definitely no light in the 2012 tunnel.”

CMBS Holders Allege 'Brazen Scheme' to Steal $60 Million. A group of commercial-mortgage backed securities investors including Angelo Gordon & Co. and Winthrop Realty Trust sued a junior lender and other parties, alleging a “brazen scheme,” to steal more than $60 million from bondholders, according to a New York court filing. The investors, three collateralized debt obligations and TCG Holdings I LLC, hold pieces of a $1.26 billion deal sold by Credit Suisse Group AG in 2007, Royal Bank of Scotland Group Plc analysts led by Richard Hill wrote in a report today. They are seeking to block Galante Holdings Inc. from purchasing a $150 million loan on the J.W. Marriott Summerlin Hotel, Resort, Spa and Casino in Las Vegas for less than $85 million, according to the court filing.

Commodities Poised for First Annual Decline Since 2008 on Europe. Commodities headed for the first annual drop since 2008, paced by declines in cotton, copper and cocoa, on concern that the European sovereign-debt crisis and a cooling Chinese economy will sap demand for raw materials. Cocoa in New York plunged 31 percent in 2011 on signs of expanding supplies from Ivory Coast, the biggest producer. Cotton is down 37 percent this year amid increasing output and dwindling demand. Copper, often seen as an indicator of economic activity as it is used in construction and automobiles, set for the first losses since 2008. China is the biggest consumer of copper.

Japan to Double Sales Tax to Reduce Debt. Japan’s ruling party agreed on a plan to double the sales tax by 2015 after weeks of internal debate and a member revolt as Prime Minister Yoshihiko Noda fights to head off another credit-rating downgrade. The proposal decided on late yesterday would raise the sales tax from 5 percent to 8 percent in April 2014 and to 10 percent in October 2015.

Wall Street Journal:

Deepening Crisis Over Euro Pits Leader Against Leader. On a chilly October evening in her austere chancellery, Angela Merkel placed a confidential call to Rome to help save the euro. Two years after the European debt crisis erupted in little Greece, the unthinkable had happened: Investors were fleeing the government debt of Italy—one of the world's biggest economies. If the selloff couldn't be stopped, Italy would go down, taking with it Europe's shared currency. Her phone call that night to the 16th-century Quirinale Palace, once a residence of popes, now home to Italy's octogenarian head of state, President Giorgio Napolitano, trod on delicate ground for a German chancellor.

IMF Warned Greece On Debt Levels With Worsening Outlook - Sources. The International Monetary Fund recently told the Greek government that a worsening economic outlook suggests the beleaguered nation may be unable to reduce its debt to sustainable levels even with a planned 50% write down in privately-held Greek government bonds, according to two officials familiar with the conversations.

A Margin for Error in Hedge-Fund Filings. Are some of the smart-money crowd playing investors for suckers? For years, finance experts have put together statistical analyses that suggest something fishy is going on with some of the reported returns in a large universe of hedge funds. New analysis conducted by Gjergji Cici of the College of William and Mary, and Alexander Kempf and Alexander Puetz of the University of Cologne adds to the questions. Their research shows the valuations hedge funds report for their stocks in quarterly filings with the Securities and Exchange Commission are sometimes at odds with actual stock prices.

Tensions Rising Over Drone Secrecy. Tensions are quietly increasing between the White House and some congressional leaders over access to sensitive information about the government's use of drones in Pakistan and Yemen, officials said. The White House has brushed aside requests for information from lawmakers, who argue that the strikes, carried out secretly by the Central Intelligence Agency and the military's Joint Special Operations Command, have broad implications for U.S. policy but don't receive adequate oversight.

Verizon(VZ) Outages, New $2 Fee Irk Customers. Verizon Wireless has built its reputation on the quality of its cellular network, touting its reliability over rival AT&T Inc., but a series of outages this month threatens the largest U.S. wireless carrier's image. On Thursday, Verizon Wireless said its engineers had fixed the third outage in December for its new high-speed data network. Some customers had complained they were getting slower connections or no signal at all. Verizon Wireless further frustrated customers Thursday by disclosing it would impose a $2 fee on those paying their bills by phone or on Verizon's website starting Jan. 15. The company said it was necessary to help provide "single-bill payment options."

Egyptian Raids on U.S. Groups Draw Ire. Egyptian security forces seized computers, printers and documents from offices of at least 17 nongovernmental organizations Thursday, including three American groups, further straining the fraying ties between Egypt's interim military leadership and its allies in Washington. The U.S. said it was "deeply concerned" about the raids. It raised the specter of clamping down on funding to Egypt's powerful military, one of Washington's closest military allies in the Middle East.

MarketWatch:

Hong Kong Exports in Danger Amid Global Slump. Hong Kong’s export growth decelerated sharply in November, reflecting the impact of cooling economic conditions in Europe and setting the stage for a grim year ahead, according to government data reported Thursday. Exports for the month were up 2% from a year earlier, easing from an 11.5% rate of expansion in October.

Treasury to Start Charging Banks for Risk Monitoring. The U.S. Treasury Department plans to start charging large banks a fee to cover the costs of the financial risk council it leads and a research office tasked with measuring threats to financial markets. The Financial Stability Oversight Council and the Office of Financial Research were created by the 2010 Dodd-Frank financial oversight law, which instructs the government to bill banks for their operations. On Thursday the Treasury Dept. released a proposed rule that would apply to banks with more than $50 billion in total assets, starting in the middle of next year. The department is proposing charging these banks a flat rate that would be applied to an institution's total consolidated assets, and would be collected twice a year. The department has yet to announce the specific fee banks will be charged because the budget for the council and research office will not be known until President Barack Obama releases his fiscal 2013 budget proposal early next year.

Farmer Anger Adds to India's Economic Worries. Usually around this time of the year, Jalgaon city in western India is abuzz with trucks ferrying mountains of fluffy white cotton to its markets. But this year, farmers have been blocking roads with burning tyres and refusing to sell their produce in a bid to force the government to prop up crop prices which they say barely cover costs. "Look at input costs. You are raising the price of fertilizers, electricity, seeds and not raising the price of cotton," farmer Yuvraj Vaman Patil, who has been holding on to most of his 1.9 tonne harvest, said at a recent rally. Patil is not alone. In recent weeks, thousands in farm belts from the state of Maharashtra in the west to Andhra Pradesh in the south have been out on the streets, demanding the government hike support prices of farm commodities to match rising costs.

Chicago Tribune:

Movie Ticket Sales Hit 16-Year Low In 2011. The curtain is falling on the worst year for Hollywood in recent memory. The movie industry sold 1.28 billion tickets in North America in 2011, according to Hollywood.com, the lowest since 1995.

Rasmussen Reports:

Daily Presidential Tracking Poll. The Rasmussen Reports daily Presidential Tracking Poll for Thursday shows that 22% of the nation's voters Strongly Approve of the way that Barack Obama is performing his role as president. Forty percent (40%) Strongly Disapprove, giving Obama a Presidential Approval Index rating of -18 (see trends).

Reuters:

U.S. Mulls Transfer of Taliban Prisoner in Perilous Peace Bid. The Obama administration is considering transferring to Afghan custody a senior Taliban official suspected of major human rights abuses as part of a long-shot bid to improve the prospects of a peace deal in Afghanistan, Reuters has learned. The potential hand-over of Mohammed Fazl, a 'high-risk detainee' held at the Guantanamo Bay military prison since early 2002, has set off alarms on Capitol Hill and among some U.S. intelligence officials. As a senior commander of the Taliban army, Fazl is alleged to be responsible for the killing of thousands of Afghanistan's minority Shi'ite Muslims between 1998 and 2001.

Steel demand growth may ease through 2015 and expectations of growth similar to the previous five years are "unrealistic," citing Zhang Changfu, vice chairman and secretary general of the China Iron and Steel Association.

Shanghai Daily:

Shanghai's land sales by value fell for the first time in three years in 2011, citing SouFun Holdings Ltd.

BOTTOM LINE: Asian indices are mostly higher, boosted by financial and real estate shares in the region. I expect US stocks to open modestly lower and to rally into the afternoon, finishing mixed. The Portfolio is 75% net long heading into the day.

Disclosed Trades: Covered some of my (IWM)/(QQQ) hedges and some of my (EEM) short

Market Exposure: Moved to 75% Net Long

BOTTOM LINE: Today's overall market action is bullish, as the S&P 500 trades slightly above its 200-day moving average despite rising Eurozone debt angst, rising global growth fears, technical resistance and high energy prices. On the positive side, Homebuilding, I-Banking, Bank Disk Drive and Steel shares are especially strong, rising more than 1.5%. Small-cap and cyclical shares are relatively strong and (XLF) has traded well throughout the day. Gold is falling -.46% and Copper is rising +.34%. On the negative side, Coal shares are under pressure, falling more than -.75%.Lumber is falling -1.74%. The 10-year yield is at session lows, falling -2 bps to 1.89%. The Germany sovereign cds is rising +.77% to 103.38 bps, the Italy sovereign cds is jumping +4.18% to 499.67 bps, the Ireland sovereign cds is rising +.89% to 723.04 bps, the Japan sovereign cds is gaining +2.4% to 143.87 bps and the UK sovereign cds is rising +1.2% to 97.67 bps. The Italian/German 10Y Yield Spread is rising +1.54% to 518.28 bps(near the highest since Dec. 1995). The Western Europe Sovereign CDS Index is still approaching its all-time high. The TED spread continues to trend higher and is very near the highest since May 2009. The 2Y Euro Swap Spread is near the highest since Nov. 2008. The 3M Euribor-OIS spread is very near the highest since February 2009. The 3M EUR/USD Cross-Currency Basis Swap is rising +5.96% to -118.50 bps, which is back to mid-Nov. levels. The Libor-OIS spread is now at the widest since May 2009, which is also noteworthy considering the equity surge off the recent lows. China Iron Ore Spot has plunged -27.90% since February 16th and -23.53% since Sept. 7th.The China Corporate Blended Spread Index remains close to another technical breakout. The Citi Asia Economic Surprise Index fell another -1.9 points today to -37.90, the lowest since April 2009.Asian equities were mixed overnight, however India’s Sensex fell another -1.2% and is down -24.2% ytd. Despite the decoupling this year, slowing economic growth and weak equity markets in the region are also red flags for US equity investors.Major European indices were modestly higher with the Bloomberg European Bank/Financial Services Index rising +1.01% today. European credit gauges are still performing very poorly given that the European debt crisis “can-kicking” solution is supposedly at hand, which remains a large red flag. Given the recent improvement in US economic data, stock rally off the lows and European debt crisis can-kicking, the 10Y T-Note continues to trade well, which is another red flag. The AAII % Bulls jumped to 40.60 this week, while the % Bears rose to 30.83. Overall, I still believe that bullish sentiment is too high given the average stock, as measured by the Value Line Geometric Growth Index(VGY), is down -17.7% from its April peak(-11.2% ytd) and the still-developing significant headwinds emanating from overseas. The reversal in the euro, gains in European equities and better US housing data are helping to boost US equities today. The quality of today’s rally is lacking, however, as many of this year’s worst-performers are leading as this year’s leaders lag and volume remains anemic. For a sustainable equity advance into the new year, I would expect to see meaningful European credit gauge improvement, subsiding hard-landing fears in key emerging markets, a rising 10-year yield, better volume, stable-to-lower energy prices and higher-quality stock market leadership. I expect US stocks to trade mixed-to-higher into the close from current levels on a bounce in the euro, short-covering, better US economic data, technical buying, seasonal strength and window-dressing.

Euro Falls to a 15-Month Low Versus Dollar on ECB Moves, Italy's Auction. The euro fell to a 15-month low against the dollar as Italian bond yields rose after the nation sold less than its maximum target at an auction, highlighting funding difficulties amid the region’s sovereign-debt crisis. The 17-nation currency dropped to a decade low versus the yen as concern increased that the European Central Bank will inject more cash into the financial system to avoid a credit crunch from the region’s debt crisis. The yen and dollar strengthened against most of their major counterparts as demand increased for safer assets. “The Italian debt auction was a little bit underwhelming,” said Nick Bennenbroek, head of currency strategy at Wells Fargo & Co. in New York. “The fact that the 10-year yield didn’t come down and they sold a bit less than that maximum target amount, that spurred further euro selling.” The euro was little changed at $1.2945 at 1:38 p.m. in New York after falling to $1.2858, the weakest level since Sept. 14, 2010.

ECB Has More Scope to Cut Rates as Prices Wane. The European Central Bank has more room to cut interest rates to a record low early next year after reports showed the sovereign debt crisis is damping inflation pressures. The rate of growth in M3 money supply, which the ECB uses as a gauge of future inflation, fell to 2 percent in November from 2.6 percent in October, the Frankfurt-based central bank said today. Growth in loans to households and companies across the 17-nation euro area also slowed, while inflation in Germany, the region’s largest economy, decelerated in December. The data reinforce the view “that underlying inflationary pressures are easing and that the ECB has ample scope to cut interest rates again in the early months of 2012,” said Howard Archer, chief European economist at IHS Global Insight in London. “Euro-zone inflation is poised to retreat markedly over the coming months.”

Libor Gap Hints at Debt Crisis Money-Market Freeze: Euro Credit. The gap between the highest and the lowest rates that banks say they can borrow from each other in dollars is close to a 2 1/2 year high, a sign Europe's failure to end the debt crisis is straining the financial industry. The divergence from reported fixings by the 18 banks contributing to the three-month London interbank offered rate reached 28 basis points yesterday, within two basis points of the widest since May 2009. Libor for three-month loans climbed to .579 percent yesterday, the most since July 2009, even as central banks injected cash into the market.

Most Germans believe the sovereign-debt crisis in the euro area isn't over, AWD Holding AG said, citing a survey the financial-services broker commissioned from polling company Forsa. Some 90% of Germans expect other euro-area countries will require a bailout in the "near future," according to the survey of 1,000 people for Hanover, Germany-based AWD.

U.S. Lawmakers Backtrack on Pledges by Expanding Federal role in Mortgages. Washington lawmakers, who began 2011 with sweeping plans to shrink the U.S. government’s role in mortgage finance, are heading into 2012 after enacting policies that expand it. An 11th-hour payroll tax cut extension signed into law last week will for the first time divert funds directly from Fannie Mae (FNMA) and Freddie Mac, the two mortgage-finance companies under U.S. conservatorship, to pay for general government expenses. That move came after two others that also could increase government involvement: Lawmakers allowed a tax break on private mortgage insurance to expire and raised loan limits for mortgages insured by the Federal Housing Administration. Advocates of private mortgage finance say they are concerned that using fees from Fannie Mae and Freddie Mac is setting a precedent that will keep the government in the mortgage business for a decade or more.

Bond Ratings Show Credit Quality May Have Peaked: Credit Markets. Credit-ratings firms are growing less optimistic about U.S. corporate borrowers, downgrading more companies as they forecast defaults will rise. The ratio of upgrades to downgrades fell to 1.08 this year from 1.4 in 2010, according to data from Moody's Capital Markets Group.

China Industrial Corn Consumption May Slow. Industrial use of corn in China, the second-biggest consumer, may grow at the slowest pace in at least five years as the economy cools, curbing the need for imports, said state-affiliated researcher Cngrain.com.

Home Sales in U.S. Beat Forecasts. The number of Americans signing contracts to buy previously owned homes rose more than forecast in November as falling prices and low borrowing costs boosted demand. The index of pending home sales (USPHTMOM) increased 7.3 percent to the highest level since April 2010 after climbing 10.4 percent the prior month, figures from the National Association of Realtors showed today in Washington. Economists forecast a 1.5 percent gain, according to the median estimate in a Bloomberg News survey.

China Stops Encouraging Foreign Investment in Auto-Industry Manufacturing. China will stop encouraging foreign investment in car manufacturing to allow for “healthy development” of a market that saw sales growth plummet to a tenth of last year’s pace. The change ends seven years of foreign-investor benefits including reduced tariffs on imported plant equipment, said Jenny Gu, a senior market analyst at LMC Automotive in Shanghai. Foreign investment in more fuel-efficient vehicles will still be encouraged, the National Development and Reform Commission and the Ministry of Commerce said in a statement.

Wall Street Journal:

Italian Bond Risk Bubbles Away. While 10-year yields below 7% are more palatable than above, they are still two percentage points above where they started the year. That is despite ECB rate cuts and a plunge in German yields of more than a percentage point. Italy has no choice but to push on with its gargantuan funding program. It can sustain high yields for some time thanks to its long average debt maturity of seven years which means the higher rates take time to feed through. But 2012 still carries a serious risk that investors again feel the heat, and leap for the exit.

Canadian Household Debt Levels Merit Monitoring: CMHC. Canadians' record level of household debt is a "serious issue" that merits closer monitoring by authorities in the years ahead, Canada Mortgage and Housing Corp. (CMH.YY) said. In a year-end publication released Thursday, CMHC - the government-owned provider of mortgage insurance in Canada - said mortgage debt accounts for 68% of total household debt, by far the largest contributor.

Egyptian Forces Storm NGOs. Egyptian soldiers and police stormed nongovernmental organization offices throughout the country Thursday, banning employees inside from leaving while they interrogated them and searched through computer files, an activist and security official said. Egyptian state television reported at least 18 offices were targeted in the raid.

Turkish Air Strike Kills 35 Kurds. Thirty-five people were killed on Turkey's border with northern Iraq late Wednesday, in what Kurdish politicians say was a Turkish air strike against civilian Kurds, mistaken for members of the outlawed Kurdistan Workers Party, or PKK. Deputy Chairman of Turkey's governing Justice and Development Party, or AK Party, Huseyin Celik, confirmed late Thursday that the 35 dead were smugglers, all under 30 years of age, but stopped short of calling them "civilians". If the dead are confirmed to be civilians, Mr. Celik said, the incident was "an operational accident."

Land Prices Surge in US Shale Oilfields. The cost of drilling rights in US shale oilfields surged during 2011 as large US energy groups and state-owned oil companies embarked on a “resource grab”, according to data provided to the Financial Times. Oil extracted in the US by “fracking” – drilling through dense rock, then fracturing it with high-pressure fluids – has grown fivefold since 2006 to 500,000 barrels a day.

Telegraph:

Eurozone Credit Crunch Fears on M3 Money Contraction. Europe is at mounting risk of a fresh credit crunch after the eurozone money supply contracted for a second month in November and the volume of private loans began to shrink. Data released by the European Central Bank shows that M3 money figures tracked by experts as a leading indicator for the economy have turned negative since August, signalling almost certain recession over coming months for the region as a whole. "The message of these numbers is that the eurozone faces a bleak 2012, with inflation falling rapidly," said Tim Congdon from International Monetary Research. "There is a desperate need to restore growth to the banking system and boost the quantity of money."

The euro currency area may break up in 2012, as steps taken to preserve it remain inadequate, Beatrice Weder di Mauro, a member of German Chancellor Angela Merkel's council of economic advisers, said in an interview. The German economy may shrink as much as .5% next year if the crisis holds back growth in global trade, Weder di Mauro said.

Cinco Dias:

Spanish banks are preparing to sell so-called contingent convertible bonds as a means to cover extra provisioning costs from a cleanup of real estate assets planned by the government. The government's latest idea is to apply a new discount of about 20% on real estate assets on their books.

Italy to Tap Markets With $11 Billion Sale of Bonds as Monti Eyes Growth. Italy will sell as much as 8.5 billion euros ($11 billion) in bonds today, one day after borrowing costs plunged at an auction of shorter-maturity debt. The Treasury in Rome will sell bonds maturing in 2014, 2018, 2021 and 2022. Italy yesterday sold 9 billion euros of 179-day bills to yield 3.251 percent, down from 6.504 percent at the last auction on Nov. 25, after the European Central Bank offered unlimited three-year loans to euro-area banks last week. Today’s auction results are expected shortly after 11 a.m. in Rome. Prime Minister Mario Monti convened a Cabinet meeting yesterday to outline his government’s next measures to boost economic growth and may offer details at a press conference scheduled for noon in Rome today. The economy contracted 0.2 percent in the third quarter and probably also shrank in the three months through December, meaning Italy may have entered its fourth recession since 2001.

Libor Gap Hints at Debt Crisis Money-Market Freeze: Euro Credit. The gap between the highest and the lowest rates that banks say they can borrow from each other in dollars is close to a 2 1/2 year high, a sign Europe's failure to end the debt crisis is straining the financial industry. The divergence from reported fixings by the 18 banks contributing to the three-month London interbank offered rate reached 28 basis points yesterday, within two basis points of the widest since May 2009. Libor for three-month loans climbed to .579 percent yesterday, the most since July 2009, even as central banks injected cash into the market.

Bond Ratings Show Credit Quality May Have Peaked: Credit Markets. Credit-ratings firms are growing less optimistic about U.S. corporate borrowers, downgrading more companies as they forecast defaults will rise. The ratio of upgrades to downgrades fell to 1.08 this year from 1.4 in 2010, according to data from Moody's Capital Markets Group. A two-year rise in U.S. companies' creditworthiness may be drawing to a close as Europe's sovereign-debt crisis roils capital markets around the world, reducing the ability of riskier borrowers to raise money from investors to finance their operations. Moody's cut more grades that it raised in the second half of the year as yields on speculative-grade debt reached a two-year high in October.

Li Ka-Shing’s Cheung Kong Loses S&P Credit Rating. Cheung Kong (Holdings) Ltd. (1), controlled by billionaire Li Ka-shing, had its long-term corporate credit rating withdrawn by Standard & Poor’s, which said it hasn’t been able to “accurately assess” the credit quality of the Hong Kong developer. The ratings company withdrew the A- “unsolicited” rating, which was based on publicly available information because it had “no access to the company management for the past three years,” S&P said in a statement yesterday. “We can’t evaluate Cheung Kong’s liquidity accurately due to recent revisions to our liquidity criteria as the company has made material acquisitions in the past 12 months and continues to be active on the acquisition trail,” analysts Christopher Lee and Bei Fu wrote in the statement.

Oil Trades Near One-Week Low on U.S. Stockpile Gain, European Debt Crisis. Oil traded near the lowest level in a week in New York after a report showed U.S. crude stockpiles surged, indicating fuel demand may be weakening as Europe’s debt crisis threatens to slow the global economy. Futures were little changed after sliding 2 percent yesterday, the first decline in seven days, as record European Central Bank lending signaled the growing risk of the region’s crisis. The euro slid to the lowest level since January against the dollar, curbing investor demand for commodities priced in the U.S. currency. Crude inventories rose 9.57 million barrels last week, according to the industry-funded American Petroleum Institute.

Takeovers Slump to Lowest in Year as Debt Crisis Saps Confidence. The value of global takeovers dropped to the lowest level in more than a year this quarter, and dealmakers say Europe’s debt crisis may hamper a recovery in 2012 as cash-rich companies hold off on major purchases. Mergers and acquisitions have slumped 16 percent from the previous three months to $457.1 billion, putting the fourth quarter on course to be the slowest since at least mid-2010, according to data compiled by Bloomberg. For the year to date, announced takeover volume has risen less than 3 percent to $2.25 trillion after regulatory hurdles scuttled AT&T Inc.’s bid for T-Mobile USA, which would have been 2011’s biggest deal. Tightening credit markets, the risk of a euro-zone collapse and stock-market swings (MXWO) have deterred companies from pursuing transformational deals that would spur sales growth, M&A bankers said.

Wall Street Journal:

Dithering at the Top Turned EU Crisis to Global Threat. At a closed-door meeting in Washington on April 14, Europe's effort to contain its debt crisis began to unravel. Inside the French ambassador's 19-bedroom mansion, finance ministers and central bankers from the world's largest economies heard Dominique Strauss-Kahn, then-head of the International Monetary Fund, deliver an ultimatum. Greece, the country that triggered the euro-zone debt crisis, would need a much bigger bailout than planned, Mr. Strauss-Kahn said. Unless Europe coughed up extra cash, the IMF, which a year earlier had agreed to share the burden with European countries, wouldn't release any more aid for Athens.

Criminal Charges Are Prepared in BP(BP) Spill. U.S. prosecutors are preparing what would be the first criminal charges against BP PLC employees stemming from the 2010 Deepwater Horizon accident, which killed 11 workers and caused the worst offshore oil spill in U.S. history, said people familiar with the matter. Prosecutors are focused on several Houston-based engineers and at least one of their supervisors at the British oil company, though the breadth of the investigation isn't known.

Merkel, Sarkozy Could Meet Jan 9 In Berlin On Euro, Fiscal Pact - EU Source. German Chancellor Angela Merkel and French President Nicolas Sarkozy could meet Jan. 9 in Berlin as they resume efforts in the new year to wrap up negotiations over a pact to more closely align economic policies among the countries that share the euro currency, a European Union official familiar with the situation told Dow Jones.

Big Funds Build Case for Housing. Big money is starting to wager on housing. Hedge funds run by Caxton Associates LP, SAC Capital Advisors LP, Avenue Capital and Blackstone Group LP have been buying housing-related investments, betting on a rebound. And formerly bearish research firm Zelman & Associates now predicts a housing pickup, as does Goldman Sachs Group Inc. Other investors seem to be making the same bet. Shares of home builders are up 30% since the end of the third quarter, as measured by the Dow Jones index tracking those shares, topping a nearly 10.5% gain for the Standard & Poor's 500.

South Korea Flags Dimmer 2012 Outlook. The South Korean government on Thursday reiterated a warning about the uncertain economic outlook while the Bank of Korea flagged weaker domestic consumer consumption, highlighting increasing headwinds for the export-dependent country against the backdrop of an unexpected decline in November's industrial output. According to Statistics Korea, the country's industrial output fell by 0.4% in November from the previous month in seasonally adjusted terms following a 0.6% fall in October, missing market expectations for a 0.4% rise.

Today's Euro Swan Dive Has Us Asking 2 Questions. We have two questions: 1) Has the ECB shot its wad as the lender of last resort providing massive liquidity to the banking system and leaving little ammunition for the distressed sovereigns; 2) Will money demand remain stable in the eurozone as the monetary base explodes? That is, will the Germans keep their money in Europe?

Funds Expect Surge of Bad Loans in China. Foreign and domestic distressed debt funds expect a big supply of bad loans to come on to the market in China after at least five years in which banks largely sat on their portfolios of troubled loans. Executives at Clearwater Capital, a Hong Kong-based fund, and at Guangzhou-based Shoreline Capital say Chinese lenders must dispose of existing bad loans to prepare for a new batch of non-performing debt, stemming from the credit binge Beijing encouraged following the global financial crisis. “Now that there is a new flow of bad loans, the banks have to dispose of their legacy loan problem,” says Ben Fanger, co-founder of Shoreline. “Deals being offered to Shoreline are at prices that are lower, on average, than in recent years. We are now having meaningful dialogues again.”

Iran Unlikely to Block Oil Shipments Through Straight of Hormuz, Analysts Say.The latest in a series of Iranian threats to block the vital Strait of Hormuz triggered a sharp response Wednesday from the U.S. Navy, although there appeared to be little chance that Tehran would make good on its warnings. Despite threats to close the narrow waterway if Western nations tighten sanctions on Iran by imposing an oil embargo, the Islamic republic needs the strait at least as much as its adversaries do, Iranian and foreign analysts said.

Daily Presidential Tracking Poll. The Rasmussen Reports daily Presidential Tracking Poll for Wednesday shows that 23% of the nation's voters Strongly Approve of the way that Barack Obama is performing his role as president. Forty-one percent (41%) Strongly Disapprove, giving Obama a Presidential Approval Index rating of -18 (see trends).

Reuters:

Mosaic(MOS) to Cut Phosphate Production on Excess Supply. Fertiliser producer Mosaic Co said it will cut phosphate production by 250,000 tonnes over the next three months as excess supply weighs on spot prices."As dealers and distributors focus on the macroeconomic uncertainty and delay purchases for the North American Spring season, near-term supply of phosphate barges on the Mississippi River has exceeded near-term demand," Chief Executive Jim Prokopanko said. Shares of the company were trading down 2 percent after the bell.

Financial Times:

Traditional Lenders Shiver as Shadow Banking Grows. The banking system, as measured by total assets, has slowly reduced in scale since the 2008 crisis. But the so-called shadow banking system has recovered to its pre-crisis peak, rising to $60tn worth of assets in 2010. The shadow banking system includes any number of financial entities such as money market funds, hedge funds and private equity groups, according to the Financial Stability Board, the international financial watchdog set up by the Group of Seven nations.

A Market-Based Plan to Regulate Banks. The Volcker rule is the part of the Dodd-Frank Bill that forbids large banks from proprietary trading. The rule cannot be implemented in its current form because legislators and regulators cannot even define precisely what a proprietary trade is.

Bond Sale Puts Italy to the Test. Italy faces a crucial test tomorrow as the technocrat government of Mario Monti launches its first big auction of long-term bonds since a disastrous upset a month ago. The outcome will set the tone for a string of debt sales through early 2012 that risk stretching the eurozone bond markets to breaking point.

China Daily:

China will shift the focus of its economic policy to the real economy next year and away from financial markets, Yi Xianrong, a researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences, wrote in a commentary. Money will be diverted to projects like irrigation and away from the real estate sector, Yi, wrote. Regulation of the realty market will continue to ensure that "unendurably high" property prices return to a "reasonable level," he said.

Financial News:

China's weak agricultural foundation may lead to consumer price rise, citing Yao Jingyuan, former chief economist at the National Bureau of Statistics

BOTTOM LINE: Asian indices are mostly lower, weighed down by industrial and commodity shares in the region. I expect US stocks to open mixed and to weaken into the afternoon, finishing modestly lower. The Portfolio is 50% net long heading into the day.

Disclosed Trades: Added to my (IWM)/(QQQ) hedges and added to my (EEM) short, then covered some of them.

Market Exposure: Moved to 50% Net Long

BOTTOM LINE: Today's overall market action is bearish, as the S&P 500 trades back below its 200-day moving average on rising Eurozone debt angst, financial sector pessimism, rising global growth fears, technical resistance and high energy prices. On the positive side, Retail, Telecom and Utility shares are holding up relatively well, falling less than -.5%. Gold is falling -2.3%, oil is declining -1.82% and Lumber is gaining +3.9%. Johnson Redbook weekly retail sales rose +3.5% this week versus a +3.2% gain the prior week. Sales have stabilized after their recent deceleration from avg. weekly gains of +4.6% during Oct. On the negative side, Coal, Alt Energy, Energy, Oil Service, Ag, Steel, Disk Drive, Networking, HMO, Construction, Homebuilding, Gaming, Airline and Education shares are under meaningful pressure, falling more than -2.0%. (XLF) has underperformed throughout the day. Cyclicals and small-caps are also relatively weak. Copper is falling -1.5% and the UBS-Bloomberg Ag Spot Index is rising +1.96%. The 10-year yield is at session lows, falling -9 bps to 1.91%. The Brazil sovereign cds is gaining +.93% to 161.66 bps. The Italian/German 10Y Yield Spread is rising +.55% to 510.44 bps(near the highest since Dec. 1995). The Western Europe Sovereign CDS Index is still approaching its all-time high. The TED spread continues to trend higher and is very near the highest since May 2009. The 2Y Euro Swap Spread is near the highest since Nov. 2008. The 3M Euribor-OIS spread is very near the highest since February 2009. The 3M EUR/USD Cross-Currency Basis Swap is rising +.89%% to -126.0 bps, which is back to late-Nov. levels. The Libor-OIS spread is now at the widest since May 2009, which is also noteworthy considering the equity surge off the recent lows. China Iron Ore Spot has plunged -28.7% since February 16th and -24.4% since Sept. 7th.The China Corporate Blended Spread Index remains close to another technical breakout. The Citi Asia Economic Surprise Index fell another -4.2 points today to -36.0, the lowest since April 2009.Asian shares continue to trade poorly. India’s Sensex fell another -.92% and is now down -23.3% ytd. Despite the decoupling this year, slowing economic growth and weak equity markets in the region are also red flags for US equity investors.Major European Indices came under pressure today, led lower by Germany(-2.01%) and Spain(-2.01%). The Bloomberg Europe Bank/Financial Services Index fell -1.7%. As well, Brazil’s Bovespa is falling -2.54% and is now down -18.4% ytd. European credit gauges are still performing very poorly given that the European debt crisis “can-kicking” solution is supposedly at hand, which remains a large red flag. Cyclicals are weighing on the major averages again today with the MS Cyclical Index dropping -2.0%. The MS Cyclical Index(CYC), which is down -15.9% ytd, has been making a series of higher lows and lower highs over the last 3 months. I suspect this pattern will resolve itself to the downside in 1Q unless the situation in Europe changes materially for the better. Given the recent improvement in US economic data and European debt crisis can-kicking, the 10Y T-Note continues to trade well, which is another red flag. The euro currency is testing its Jan. 10 low. While short euro is a crowded trade and the currency is technically oversold, I still see substantial weakness in the euro over the intermediate-term. Year-end window-dressing, short-covering, better US economic data and seasonal strength had been boosting US stocks. For a sustainable equity advance into the new year, I would expect to see meaningful European credit gauge improvement, subsiding hard-landing fears in key emerging markets, better volume, lower energy prices and higher-quality stock market leadership. I expect US stocks to trade mixed-to-lower into the close from current levels on rising Eurozone debt angst, rising global growth fears, technical resistance, profit-taking, financial sector pessimism, more shorting and high energy prices.

The positions and strategies discussed on BETWEEN THE HEDGES are offered for entertainment purposes only and are in no way intended to serve as personal investing advice. Readers should not make any investment decision without first conducting their own thorough due diligence. Readers should assume the editor of this blog holds a position in any securities discussed, recommended or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in anyway, considered liable for the investment performance of any securities or strategies discussed.